Government Spending Effects in a Policy Constrained Environment

June 12, 2020

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Format: Chicago

Ruoyun Mao, and Shu-Chun Susan Yang. Government Spending Effects in a Policy Constrained Environment, (USA: International Monetary Fund, 2020) accessed December 21, 2024

Disclaimer: IMF Working Papers describe research in progress by the author(s) and are published to elicit comments and to encourage debate. The views expressed in IMF Working Papers are those of the author(s) and do not necessarily represent the views of the IMF, its Executive Board, or IMF management.

Summary

The theoretical literature generally finds that government spending multipliers are bigger than unity in a low interest rate environment. Using a fully nonlinear New Keynesian model, we show that such big multipliers can decrease when 1) an initial debt-to-GDP ratio is higher, 2) tax burden is higher, 3) debt maturity is longer, and 4) monetary policy is more responsive to inflation. When monetary and fiscal policy regimes can switch, policy uncertainty also reduces spending multipliers. In particular, when higher inflation induces a rising probability to switch to a regime in which monetary policy actively controls inflation and fiscal policy raises future taxes to stabilize government debt, the multipliers can fall much below unity, especially with an initial high debt ratio. Our findings help reconcile the mixed empirical evidence on government spending effects with low interest rates.

Subject: Consumption, Expenditure, Financial services, Inflation, National accounts, Prices, Public debt, Real interest rates, Zero lower bound

Keywords: Consumption, Fiscal multiplier, Fiscal policy, Fiscal policy interaction, Global, Government spending effect, Government spending effects, Government spending increase, Government spending multiplier, Inflation, Monetary, Nominal interest rate, Nonlinear New Keynesian models, Output multiplier, Policy uncertainty, Real interest rates, Regime F, Regime-switching policy, WP, Zero lower bound

Publication Details

Pages:

44
Volume:

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DOI:

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Issue:

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Series:

Working Paper No. 2020/091
Stock No:

WPIEA2020091
ISBN:

9781513546797
ISSN:

1018-5941

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